Are we pushing on a string or crowding out?

This is an important question which Brad DeLong asks (Hat tip Mark Thoma). Here’s the logic:

Right now, if you ask the decisive members of congress—by which I mean the Blue Dog Democrats in the House, or the most conservative Democrats and most liberal Republicans in the Senate —why the president and the Congress are not doing more to reduce unemployment and boost spending and income, the answer you’ll get is … well, you probably wouldn’t get an intelligible answer.

But if you did get an explanation for the lack of congressional action it would go something like this: Attempts to … boost spending would (a) increase the national debt burden on future taxpayers and (b) lead to a large decline in bond prices and a boost in interest rates. Why? Because businesses would try to increase their liquidity to support higher spending, driving up interest rates, which, in turn, would cause businesses to cut back on investment, thus neutralizing most or all of the stimulative policies.

Similarly, if you were to ask the Federal Reserve why it isn’t doing more to reduce unemployment and boost spending and income, the answer you would get is this: Spending is in no way constrained by a shortage of liquidity…, indeed we have “flooded the zone” with liquidity. As a result, the Fed is disinclined to pursue additional tweaks … in … liquidity because it fears such efforts would fuel destructive inflation in the future without boosting employment and spending in the present.

Both of these arguments are comprehensible… But they cannot both be true at the same time. Either the economy is so awash in liquidity that the Federal Reserve cannot do much to boost spending—in which case additional spending by the government won’t generate any substantial rise in interest rates. Or additional government spending will crowd out investment…—in which case the economy is not awash in liquidity, and quantitative easing by the Federal Reserve could do a lot right now to boost spending and employment.

It appears that what we have here is a failure to communicate. …


  • a) the Fed is pushing on a string and can’t get any traction on boosting spending or;
  • b) the fiscal stimulus we have just seen is about to crowd out massive private sector investment due to come online.

Situations A and B are mutually exclusive. You know what I think the answer is.

More here.

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